Martin Kelleher is partner and Head of Corporate at Mason Hayes & Curran. He explains that each of the three sources of finance — debt, vendor finance and private equity — has pros and cons.   “Each should be evaluated on the basis of cost and governance,” he explains. For debt and vendor finance, this cost includes arrangement fees, interest payments, and capital repayments. For equity, it represents the lost future value of the shareholding which is to be held by the equity partner.

“In terms of governance, for debt and vendor finance, this will be the restrictions imposed on the business such as maintaining financial covenants, and consents required for certain business decisions. For equity partners, this will be the minority protections required by such shareholders as well matters such as board seats, restrictions of share transfers,” Kelleher says. “An equity partner will expect to play a more active role in the management of the business than a debt provider.” 

David Martin, capital and debt advisory partner with EY, says that when it comes to sources of finance for M&A, debt can have many benefits for businesses, the most important being maintaining control. “Unlike other capital products, it is a non-dilutive source of capital that can increase returns for shareholders,” he explains. It can also be a cheaper form of capital — despite the interest rate environment over the last 18 months, debt continues to be a suitable product to fund your business and its acquisition activity, he adds. 

Martin notes an interesting trend currently in the Irish market is that of combining debt sources. “Where previously, many Irish borrowers saw the choice as being between a bank or an alternative lender, today many will now work with both a bank and a non-bank lender to fund their acquisition plans, demonstrating that banks and non-bank lenders can co-exist, which is certainly the international convention.”

It’s also worth noting, he says, that over the last 18 months there has been a noticeable increase in the number of international debt funders looking to deploy capital in the market. This demonstrates international players’ positivity in relation to the market, and means greater choice and competition amongst lenders, resulting in better terms and conditions for Irish borrowers. 

“Term loans, working capital facilities and long-term debt products including private placement are all areas with multiple products in the marketplace, and this allows borrowers to be more innovative in their debt raising and allows them to focus on diversifying their debt products, repayment profiles and ultimately their refinance risk.”

In terms of leverage, EY has also observed a trend, both domestically and internationally, of the “flight to quality” from the banks. “As a result, we have witnessed borrowers getting competitive terms with good margins for both acquisitions and refinancing.” Martin advises that whilst there can be pitfalls of taking a significant amount of debt, these can be attenuated by a considered funding plan. “A well-thought out debt plan will mitigate many of the risks of raising debt, and assessing your cash flow requirements over the tenor of your debt facilities will allow for mitigating against overleveraged,” he says. “Furthermore, allowing buffers in your debt facilities for the ‘unexpected events’ in an acquisition will allow for headroom against defaults.”

He also points out that the deep pool of capital providers in the market has contributed to an increase in the array of products in the marketplace. “This has allowed businesses to be savvier in structuring their debt facilities to allow businesses to match their funding requirement with the appropriate funding solution.” Once the financing plan is drawn up, focus must go to allocating risk — especially given the large sums often involved in M&As.

Diarmaid Gavin, partner with corporate law firm RDJ, points out that when someone is buying a business is buying a company, there are no statutory protections in law: “the principle of caveat emptor or ‘buyer beware’ very much applies.” Gavin says that while potential buyers will carry out extensive due diligence, across the legal, financial, operational and technical aspects of the target company, warranties and indemnities are the two mechanisms that provide them with protection in the event of the deal going south. 

Warranties are statements of fact that a seller would make in relation to the business, which, if they subsequently transpire to be untrue, will give the buyer then to potentially sue for damages, explains Gavin. “Typical warranties might be around the ownership of the company, the accounts, or that there’s no litigation in the business. What they do is that they generally confirm what the buyer has learned during their due diligence process. Warranties are given at a particular moment in time, they aren’t particularly future-looking.”

But a warranty that transpires to be untrue allows the buyer to sue for damages, he says. “For example, if a warranty was given that the company wasn’t subject to any litigation and it turned out there was a big claim that they hadn’t told the buyer about, the buyer will be able to sue for the difference of what the business was worth if the warranty was true and what the business is actually worth following the warranty breach.”

If the buyer is aware of any potential issues with the target company, however, the alternative is an indemnity, which is essentially a promise to pay for any liability or loss that would be incurred in certain circumstances.  “Indemnities can be used where a particular problem is known, such as an ongoing court case where the outcome is not yet known,” explains Gavin. “It is designed to provide compensation on a euro for euro basis. Warranty deals with the unknown risks whereas indemnity deals with the known risks but are unable to quantify it so can’t reflect it in the price.”

Other mechanisms outside of formal warranty and indemnity include escrow, whereby money is held back from the deal and instead put into a third party’s account. “This would be for a percentage of the purchase price and can be held for a few months or even up to two years,” Gavin says, adding that these can be quite commonly employed in M&As.

Warranty and indemnity insurance is a product that has become more and more popular in the last number of years.  “A buyer may not always be able to get the level of warranty coverage they desire in the transaction or equally the sellers may not be willing to give that level of coverage,” says Gavin.

“For example if you are buying the business from a liquidator or a receiver, they just don’t offer warranties, so there is no coverage. Warranty and indemnity insurance plugs the gaps, providing an insurance policy that will pay out in the event of a claim.”

He notes that there are now a number of providers of W&I insurance, mostly based in the UK but servicing the Irish market. Of these products, buyer-side policies are by far the most common, whereas seller side policies are less common and tend to be more expensive. “W&I insurance will only cover areas that have been subject to the due diligence exercise and will only cover risks that are unknown at the time of the deal going through.”